October was another positive month for investors. US large-caps and small-caps led the way, while international stocks and bonds also increased. This year, international stocks are the clear leader, followed by US large-caps. US small-caps and bonds have also done well.
Stocks vs. Companies – The Parable of Mr. Market
In 1949, Benjamin Graham wrote “The Intelligent Investor,” one of the most popular books ever on the topic of investing. During one section of the book, Graham tells a parable that asks the reader to imagine they are in a business partnership with a man named Mr. Market. His sole objective is to appear daily and name a price at which he will either buy your shares of the business or sell you his. It does not matter to him which you decide to do – or even if you decide to do nothing at all. Every day, he comes back with a new price.
One other thing – Mr. Market can be wildly erratic. Some days, he names a very high price because he sees only good times ahead and doesn’t want to sell too low. On other days, he offers a low price. On these days, he is worried about the future of the world and wants to avoid the chance of buying your shares at all.
The story is meant to illustrate the difference between the price of the stock market and the value of the underlying companies. Graham urges the reader to use Mr. Market to his or her advantage, rather than getting swept up in the emotionally driven daily price fluctuations.
The following chart shows this concept visually. The line represents the value of the stock market (S&P 500) while the shaded blue section is the company earnings per share:
We can make the following observations from this:
- In the very long run, the stock market should grow at a rate comparable to company earnings growth. In other words, there is a relationship between the two. In order for stocks to go up in value, the companies have to earn more.
- As investors, we experience many short-run time frames during the long run. Most of the time, the stock market is oscillating much more wildly than the business performance of the companies.
- When we buy stocks in order to invest over long time frames, it’s helpful to be aware of relationship between the price and the business performance.
- While we can use today’s prices and earnings to make inferences about the future, tomorrow’s price and earnings are both unknown.
- Ultimately, the prices at which we buy and sell stocks determine our returns. The goal should be to use Mr. Market to our advantage and make rational (rather than emotional) decisions.
If you would like to further discuss Mr. Market, and how we can use him to our advantage, please let me know.
